Fiscal Policy at HomePOLICIES:If the government expands domestic spending by increasing government purchases then G will reduce national savings. With an unchanged world real interest rate, investment will remain unchanged. Savings will fall below investment. A trade deficit is run. If the government decreases taxes, T decreases, disposable income increases, consumption increases, and national savings decreases. *These both shift the vertical line that represents savings to the left. * Starting from a balanced trade, a change in fiscal policy that reduces national savings leads to atrade deficit. REAL EXCHANGE RATE:If the government reduces national savings by increasing government purchases or cutting taxes a trade deficit will occur. The real exchange rate will increase, and net exports will be reduced. Fiscal Policy AbroadPOLICIES:If a foreign government increases their government purchases then world savings is decreases. This causes the world interest rate to rise. This will reduce investment. Savings will now exceed investment. This will lead to a trade surplus at home. *ONLY HE WORLD INTEREST RATE WILL INCREASEREAL EXCHANGE RATE:If foreign governments increase government purchases or cuts taxes the result will be a reduction in world savings and a rise in the world interest rate. This causes a trade surplus. Shifts in Investment DemandPOLICIES:If investment shifts outward, the demand for investment goods at every interest rate increases, investment will be greater than savings. Net capital outflow will now be negative. This causes a trade deficit. REAL EXCHANGE RATE:If invest demand increases then this increase will lead to higher investment. This means the S – I curve will shift to the left, causing a trade deficit.Wage Rigidity:1. Minimum-Wage laws2. Monopoly power of unions3.
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